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What is a home equity line of credit (HELOC)?
A home equity line of credit, also known as a HELOC, is a line of credit secured by your home that gives you a revolving credit line to use for large expenses. It can also help consolidate higher-interest rate debt on other loans such as credit cards. A HELOC often has a lower interest rate than some other common types of loans, and the interest may be tax deductible.
With a HELOC, you borrow against your equity, which is the home’s value minus the amount you owe on the primary mortgage. You can also get a HELOC if you own your home outright, in which case the HELOC is the primary mortgage rather than a second one. When you’re shopping around for a loan, borrowing from the equity in your home will often get you the best rate.
How a HELOC works
Much like a credit card that allows you to borrow against your spending limit, a HELOC gives you the flexibility to borrow against your home equity, repay and repeat.
Most HELOCs have adjustable interest rates. This means that as baseline interest rates go up or down, the interest rate on your HELOC will adjust, too. However, because a HELOC is secured against the value of your home, the interest is typically closer to a mortgage rate than it is to a credit card rate.
To set your rate, the lender will start with an index rate, then add a markup depending on your credit profile. Generally, the higher your credit score, the lower the markup. That markup is called the margin, and you should ask to see the amount before you sign off on the HELOC.
You typically have 10 years to withdraw cash from a home equity line of credit, while paying back only interest, and then another 20 years to pay back your principal plus interest.
To calculate your estimated line of credit for a HELOC, you will want to use the following calculation:
- Multiply: (Your home’s value) ✕ (your lender’s LTV percentage) = maximum amount of borrowable equity
- Subtract: (Maximum amount of borrowable equity) − (what you currently owe on your mortgage) = your HELOC credit limit
Lender requirements will vary, but here’s what you’ll generally need to get a HELOC:
- A debt-to-income ratio that’s 50% or less.
- A credit score of 640 or higher.
- A home value that’s at least 15% more than you owe.
If you have less than 20% equity in your house, you probably won’t be eligible for a HELOC loan. You may be able to speed up equity growth by:
- Refinancing into a shorter-term mortgage.
- Making home improvements that increase value.
- Paying a little extra toward your mortgage principal every month.
Qualifying for a HELOC
To qualify for a HELOC, you need to have available equity in your home, meaning that the amount you owe on your home must be less than the value of your home. You can typically borrow up to 85% of the value of your home minus the amount you owe. Also, a lender generally looks at your credit score and history, employment history, monthly income and monthly debts, just as when you got your mortgage loan.
What Can You Use A HELOC For?
HELOCs are designed to be a flexible way to leverage the equity in your home. There are no use restrictions for the funds you receive, so a HELOC can be flexible to what you need it for. Borrowers can use HELOC funds for a variety of purposes, including home improvements, education and the consolidation of high-interest credit card debt. Since you risk losing your home if you can’t pay back your loan, a home equity line of credit is best reserved for expenses that will help build wealth or bolster emergency funds.